ATS Corp (ATS) 2005 Q3 法說會逐字稿

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  • Operator

  • Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the ATS third-quarter results conference call. (OPERATOR INSTRUCTIONS)

  • I remind you that our presentation today may contain forward-looking statements reflecting the Company's expectations regarding its future growth, results and performance. These forward-looking statements reflect the current views of the Company's management, and are subject to various risks and uncertainties which could cause the Company's future growth, results and performance to differ materially from those expressed in or implied by these statements. Certain of these risks are described in the ATS Annual Report. ATS disclaims any intentions or obligations to update or revise these forward-looking statements.

  • This call is being recorded on Wednesday, February 9, 2005 at 10 AM Eastern Time.

  • I would now like to turn the conference over to Mr. Larry Tapp, Chairman of the Board of ATS. Mr. Tapp, please go ahead.

  • Larry Tapp - Chairman

  • Good morning, ladies and gentlemen. Thanks for attending. I am joined today by Ron Jutras, Mike Cybulski, Bruce Seely, Gerry Beard and Carl Galloway. The purpose of this call is to review our financial performance, and I will yield the floor to Ron momentarily for that purpose. But first I want to take this public opportunity to discuss our succession plan, and most important to pay tribute to Klaus Woerner.

  • As a friend and business associate of Klaus's for better than part of 15 years, I'm deeply saddened by his tragic and sudden passing on Monday. Klaus was truly a one-of-a-kind person who made an enormous contribution to the automation industry and to the community here in Kitchener-Waterloo. He was a tireless worker, a committed leader, a truly great entrepreneur, and a loving father and husband. ATS will be just one of his lasting legacies.

  • Klaus was also someone who passionately believed in the power of teamwork. He made life very easy for us by creating a strong management team and a well-developed succession plan. We've already seen the outcome of that plan in action with Ron's appointment yesterday afternoon to position of ATS President and CEO. Ron needs no introduction. He has provided a steady hand as the Company's CFO since 1985, and successfully took on new responsibilities of the Company's Chief Operating Officer since last spring. The Board has the utmost confidence in Ron, and we know he will make a great leader.

  • To underscore the fact that ATS has considerable bench strength, Ron has been able to ensure great continuity in the area of corporate finance by appointing Gerry Beard to the position of Vice President and Chief Financial Officer. Gerry joined ATS four years ago, is a CA, a CPA, and has developed significant knowledge of our global operations.

  • Ron and Gerry will continue to receive the benefit of the knowledge and experience resident in the Company's executive committee. This committee was formed in 2002 and includes Mike Cybulski and Bruce Seely who are with us today, as well as Marilyn Wolfe, Uwe Geissinger and Jim Sheldon. Ron, with the help of his management team and the efforts of our 4,000 valued employees, will no doubt put their stamp on the Company in the months and years to come, and we look forward to this.

  • But most important today we recognize Klaus for all he has done in the service of ATS, our shareholders, our employees, our customers and the automation industry over the past quarter century. Klaus would have argued that no single person is responsible for ATS's success. That's true, but I think it is equally true that it took the genius, vision and selfless commitment of one very special entrepreneur to make ATS possible in the first place. Klaus, you are gone but never forgotten.

  • Now I would like to turn the call over to Ron.

  • Ron Jutras - President & CEO

  • Thank you and good morning. I want to thank Larry for being here today, for his kind words of support, and for eloquently summarizing how we all felt about Klaus. He truly was a remarkable person, and he was a very dear friend and colleague to me personally, and I will miss him greatly. I know my colleagues here feel the same way.

  • But speaking on behalf of all ATS employees, I can tell you we all intend to honor Klaus's legacy the best way we can -- by continuing to use our industry leadership to benefit our shareholders and customers. This is what Klaus wanted and expected from ATS, and we intend to do just that.

  • I also know that Klaus would very much like to have been here today, and would have been impatient for us to share the good results for this most recent quarter with you. So I will get started with a brief performance review, followed by our outlook.

  • Automation Systems Group made outstanding progress in the third quarter. ASG operating earnings were up 178 percent from the same period a year ago, driven by 22 percent growth in revenue over Q3 of last year and more broad-based contributions by our ASG operating divisions. In particular, for the first time in 13 quarters our US West Coast operations were strong and profitable. This is great news. However, we still expect increased contributions going forward.

  • This progress reflects the efforts of our new management team in Corvallis, Oregon and the benefits of the large customer assignments we won during the summer months in flat-panel display and health-care markets. These assignments are progressing according to plan.

  • We are also currently constructing a 57,000 square foot addition to one of the two production facilities we currently have in Oregon. This step will allow us to vacate the one expensive leased factory of 85,000 square feet at the termination of lease and consolidate our operations into more efficient space. Overall this is a smart investment that we believe will significantly reduce our operating costs going forward.

  • We also continue to generate good operating results in our largest facilities here in Cambridge. Additionally, we saw improved performance in a number of our other facilities in the third quarter, and we expect further improvements going forward, reflecting better utilization across our global ASG facilities.

  • In Ohio, we're on capacity. And to accommodate present and future growth in medical, automotive and electronic assembly, we have agreed to purchase a 37,000 square foot facility for US$1.6 million. This plant will open in March and is well located, being adjacent to our existing ASG facility. This is a worthwhile investment given the excellent potential in this region and the strong and consistent record of performance that we have in Ohio.

  • Europe remains a challenge because of the weak economy, the high relative value of the euro, and the fact that our European operations have traditionally been more tuned to the automotive market, which is currently experiencing considerable volatility. We believe an important part of strengthening our performance in Europe is to broaden our industry diversification, as we have done in North America.

  • We took a significant step in this direction in the third quarter, with our European operations being awarded their first significant health-care order. For this project we're transferring building skills and knowledge that will help establish ATS Europe as the automator of choice for European health-care industries. It's a calculated step with a repeat ATS customer. However, we know there will be still costs associated with the strategic move. As a result, we anticipated there will be a loss on this first project, and the estimated amount has been provided for right up front in our third-quarter results. However, we expect long-term benefits from the investment given the number of health-care companies located on the Continent and the importance of building our global health-care credentials and reputation.

  • Clearly ATS continues to benefit from our drive into the health-care market. ASG health-care revenue more than doubled in the third quarter in the same period a year ago. This significant acceleration, combined with a 15 percent increase in ASG computer electronics revenue and a 67 percent increase in revenue from other markets, including consumer products, fully offset the impact of lower automotive revenue. In the quarter we had the best balance ever between our three largest target markets.

  • Consistent with this highly successful push into broader areas of health-care, we now are aggressively enhancing our standard product technologies, namely SuperTrak, our MACS machine control software system, and SmartVision to meet health-care industry needs in new application areas. A significant portion of this development work is being done by customer jobs, and was expensed as incurred in the third quarter, thereby reducing operating margins.

  • Coupled with the costs associated with the first time health-care project I just mentioned in Europe, technology development kept ASG margin progress in check on a sequential second-quarter to third-quarter basis. However, what we gave up in the third quarter we expect we will paid back handsomely on future health-care assignments, and now with future health-care business to be won in Europe. Further development of our health-care technologies and skill sets is a key part of our operating agenda, and I will discuss this later on the call.

  • To summarize, ASG operating margins more than doubled over Q3 of last year, and stood at 6.8 percent. This is strong year-over-year progress. However, we expect to do more. We are committed to achieving even higher margin levels in ASG going forward. With time and improved market conditions, I believe in ASG can return to its traditional benchmarks for operating margins in low- to- mid-teens.

  • Before concluding on ASG, I'm delighted to report that our contract equipment manufacturing effort focused on the health-care industry is performing very well. Revenue in the third quarter was $8.9 million compared to 5.1 million in Q3 of last year, and it contributed positively to operating earnings. You may recall that this new line of business for health-care customers is consolidated in the ASG results. But we're leveraging the Precision Components Group's repetitive manufacturing skill sets, infrastructure, facilities and lower average wage rates to fulfill these contract equipment manufacturing assignments. We believe this is a very good use of PCG resources and skills. We also believe there is a very significant market for contract equipment manufacturing globally, particularly in health-care and electronics. We recently added dedicated sales staff to grow this business and capitalize upon the strategic opportunity.

  • Let's turn to the rest of the Precision Components Groups. As previously discussed, FX and higher material costs have created major challenges for PCG. In addition, the third quarter was very weak for automotive, the group's primary market. In fact, our automotive customers took action to reduce inventory levels through temporary plant shutdowns in December. PCG followed suit by doubling its traditional one-week Christmas shutdown. As a result, from a production loading and revenue perspective, third quarter looked more like a summer quarter.

  • Even though revenue was more than $1 million lower than in Q2, PCG reduced its operating loss 17 percent on a sequential basis from Q2. This is due to a combination of very aggressive cost cutting through staff reductions and efficiency improvements. Let me add some detail on these actions.

  • PCG staffing complement was 7 percent lower at end of the third quarter compared to the end of the second, and 21 percent lower year-over-year. Through productivity improvement teams formed as a result of our Six Sigma activities, our plastics group made healthy cycle rate improvements and reduced scrap. We expect similar significant gains in other PCG divisions going forward since plastics has been the first to implement Six Sigma and has had a head start.

  • As you know, PCG is also applying a global material sourcing strategy to reduce its costs. But because it's taking longer to qualify its Chinese suppliers than we expected, this initiative is well behind our first year expectations. Cost savings amounted to less than $100,000 in Q3. But while progress is slower than we would like, we are making progress.

  • Also in the quarter, we passed along 69 percent of higher steel costs through surcharges. We expect to bring that up to 85 percent in the fourth quarter as our new pricing takes effect with customers on other negotiated transactions.

  • The real payoff from all of our improvement activities has yet to be fully realized. And we also know more needs to be done to get PCG back to acceptable performance. Last Friday we announced we are closing PCG's McAllen manufacturing plant and consolidating the customer programs into the larger Cambridge facilities. This closing will strengthen the economics of the Group's continuing operations by eliminating McAllen's overhead costs and improving the capacity utilization of the remaining PCG operations. The transfer of existing customer programs from the McAllen facility into existing PCG facilities in Cambridge is scheduled to be complete by June of 2005. We will start to see costs and efficiency benefits thereafter.

  • We've estimated that the cash cost of this plant's consolidation will be approximately $1 million. There may also be non-cash charges, depending on the amount of value realized on disposition of assets, including the McAllen factory, but it's too early to estimate these. The total investment in land, building and equipment in McAllen was US$5 million at December 31, 2004, to give you a bit of a benchmark to look at.

  • We also completed the divestiture of the thermal products business during the third quarter.

  • In context we're making PCG leaner and more focused around core activities where we can derive good value. This improvement program will take time, particularly because automobile volumes are not stable right now.

  • Now let's look at our Solar Group. It had an excellent quarter. As expected, Photowatt made a significant contribution to consolidated revenue and earnings. In fact, we're delighted to report that it set a new quarterly record for operating earnings, surpassing the previous record set in Q1 of this year.

  • The solar market is extremely robust, and therein lies both our opportunity, as well as our challenge. The opportunity is that we can sell everything we can make. The challenge is the risk of silicon shortages will curtail our growth. Silicon is a key ingredient in solar cells, and the solar industry has to compete with semiconductor for silicon supply. The rapid growth of solar and a recovery in semiconductor -- with the rapid growth in solar and a recovery in semiconductor underway, silicon shortages are becoming a major concern for pretty much the whole solar industry. As a result, the spot market prices of silicon have risen dramatically this year, a jump of over 50 percent during Q3 alone. And we expect pricing may continue to be volatile.

  • Photowatt has worked hard to maintain its current supply, and has committed silicon sources for a substantial portion of its capacity for the next six months. This leaves it in reasonably good shape for the balance of this year and while not guarantee, we also believe we have sources to support most of our plans for fiscal 2006. I'll talk more about Photowatt's outlook in a few minutes.

  • In terms of Solar Group's third-quarter operating performance, margin increased to a record 9.1 percent compared to 7.7 percent in Q3 of last year. This reflects internal operating improvements, not pricing. These improvements have included gains from greater efficiencies, cost reductions, smart investments, and economies of scale, improvements that should provide returns well into the future.

  • Next, let me update you on Spheral Solar Power, SSP. We're very bullish on SSP's prospects based on several factors -- one, the market for solar is growing rapidly; second, SSP is a revolutionary technology that opens new solar markets; and three, we're confident that SSP uses much less silicon for per watt of solar power produced than the other conventional solar technology. We also expected to be able to use less pure silicon feedstock, which should mean even lower costs. This means a significant costs and supply advantage manager for SSP which will increase if silicon prices remain high and shortages continue.

  • The challenge with SSP today is to deliver the goods. Understandably, given the complexity involved, commissioning factory is taking time. We have spoken at length about the incremental commissioning process in previous calls. We are making good progress. Every workstation facility has now been activated, and for the first time we have processed small quantities of product back to front in the new factory without any use of the pilot line equipment. Production of these complete commercial-grade SSP products is a very big step forward.

  • During the fourth quarter -- in fact, later this month -- we expect SSP to complete reliability testing and ship our first commercial-grade solar modules to customers. We expect volumes in the quarter will likely be modest, because we must continue to refine our process steps to support our ramp up. This is another very important step forward because we will ship commercial SSP modules to more than a dozen customers, including catalog retailers. Our goal is that SSP will ramp up production during the fiscal 2006 year and will be close its nameplate capacity late in the fiscal period.

  • Looking at individual SSP products, our Flex module has been going through a very rigorous lifecycle testing with excellent results to date, significantly exceeding both durability and reliability requirements. We have also developed a promising prototype of our integrated solar roofing technology in concert with our partners and Elk Corporation. Elk is now moving the products through focus groups to ensure it's positioned and marketed effectively, and we're conducting accelerated life testing to verify the product can withstand the harsh environmental conditions.

  • We want to harvest SSP's full potential as quickly as possible. However, SSP is a long-term opportunity, and we're committing the time to do things right in order to maximize the returns from this initiative. As we have previously described, the deferred development period for SSP will end no later than the second quarter of fiscal 2006, which is September 30th.

  • There's one more point I'd like to make about Solar. It has achieved an important milestone this year. Even without any revenues from SSP, Solar is now our second-largest business segment behind ASG. Year-to-date Solar revenues are 18 percent of our consolidated revenue, and they're growing quickly. The fact is that there significant differences and opportunities and growth potential between the Solar Group and PCG, and with this milestone we hope the significance and value of the Solar Group will begin to become more recognized.

  • That's the performance review; now our outlook. Corporate-wide we believe we can continue to drive earnings momentum in the fourth quarter, in large part on the strength of ASG order backlog and better capacity utilization across our global operations. At quarter end, ASG backlog remained at a very healthy $232 million. That's 28 percent higher than a year ago. New order bookings for the quarter were 32 percent higher than last year. Mid-term bookings for the first five weeks of the fourth quarter were approximately $26 million. Looking forward, quotation activity overall remains very strong, reflecting our strong leading market position and our growing penetration into health-care. Our backlog and our prospects continue to include a good number of new assignments, as well as repeat, systems; in other words, the kind of mix that should produce attractive margins.

  • For Precision Components, while we intend to further reduce our operating losses, we likely will not break even in the fourth quarter. Unfortunately, it will take more time for our rationalization initiatives and proven (ph) programs to pay off. We also need some stability from the automotive industry. On the bright side, now that the thermal products assets have been removed from our plant, we can make use of this space for higher-margin work, including contract equipment manufacturing and for Automation Systems assembly space. Closing McAllen will also provide meaningful benefits to overall group performance following the closing, which I said is expected at the end of June.

  • On the Solar front, we expect Photowatt revenue will tail off slightly in the fourth quarter compared to the third quarter of this year because of the normal winter seasonality in the Solar industry, and also reflecting some risks associated with silicon supply that I commented on earlier. (indiscernible) Photowatt is already well on its way to a record year for revenues and earnings, and the fourth quarter should produce solid performance overall.

  • In total, we believe ATS is well positioned for the future. We intend to make the most of our opportunities. At the top of the agenda is the turnaround in PCG, but we also have several other initiatives under way to stimulate earnings growth. As part of our core ongoing strategy we have a very active technology development agenda. As I said earlier, this includes enhancing our existing standard product technologies to health-care applications. We aren't stopping there, because we see attractive opportunities for us to develop and sell sophisticated standard platforms that can be readily customized for common applications. We've talked about this strategy as part of our technology development roadmap in the last call, and I'm pleased to report that we will launch three very important new standard platforms at the upcoming Interphex Trade Show in New York in April. We will follow that by introducing a very exciting new standard pharmaceutical packaging system at the PACex Trade Show in September.

  • The first system we will introduce is a high-speed continuous motion vision inspection platform for glass vials and ampoules and pre-filled syringes. This system will offer significant advantages over competing technology because it has much higher fault detection rates and a much lower false reject rate. We expect it's a major breakthrough in productivity and throughput for our customers.

  • The second platform is also a vision inspection system, this one for plastic ampoules that offers superior performance in a sterile environment. Currently vision inspection in the applications we're targeting is very labor-intensive. This breakthrough changes that.

  • The third product is (indiscernible) commercial DHP-compatible robotic platform that is ideal for in-process aseptic tests in small-scale production that is characteristic of clinical trials.

  • The fourth product is code-named SuperPak (ph), it's a flexible packaging solution. And as you might expect, it makes use of our SuperTrak technology. I don't want to get too far ahead here and discusses the system since it won't be introduced until the fall, but it would be ideal for secondary packaging applications, meaning labeling and packing of finished pharmaceuticals.

  • Our goal with this aggressive technology program is to broaden our health-care market growth prospects by adding new application-ready solutions to our repertoire, further differentiating ATS, and expanding our portfolio platforms that can be quickly and cost effectively built and deployed at low risk and attractive margin. We have every reason to believe that our demonstrations at Interphex in April will be the catalyst for new orders.

  • Another catalyst is ATS Compliance Solutions, our consulting service for health-care customers. Since opening last April, Compliance Solutions has already significantly surpassed its first year revenue target for consulting. But more important, it is developing customer relationships for ASG that we believe will lead to substantial new systems orders. In fact, it's already played a role in helping us win significant automation assignments, and there is a growing number of solid prospects in the pipeline.

  • I believe as you consider the breadth and depth of our capabilities and involvement in health-care to date, you'll see the results of this disciplined strategy of rewarding ATS and its shareholders with revenues, earnings and returns. More importantly, we really are only just getting started.

  • In closing, I believe our momentum is building. I also believe that ATS is making the most of our industry's leadership and strong balance sheet to further develop the capabilities and opportunities we need to drive exciting, long-term growth and outstanding earnings. We remain committed to a course of action that will enhance our results immediately and over time.

  • Now we would like to invite your questions. Operator, would you please open the lines to questions?

  • Operator

  • (OPERATOR INSTRUCTIONS) Pierre Yves Terrisse, Desjardins Securities.

  • Pierre Yves Terrisse - Analyst

  • Ron, you mentioned your margin in ASG, that you expect that it could come back to historical level. Historical level operating margin was high around 17, 18 percent back in 1999. But that was in a context where the dollar was obviously much weaker and raw material prices were lower. So do you believe that that number is achievable over time, even in this context?

  • Ron Jutras - President & CEO

  • I said that I think that our targets are in the -- I said low- to- mid-teens. So we obviously our ratcheting that back a little bit because of the currency. I'm so optimistic we'll do better, but I think from a standpoint of what we're saying right now, I think that's a realistic goal.

  • Pierre Yves Terrisse - Analyst

  • Regarding your new initiative, SSP, you will start recognizing revenue in fiscal '06?

  • Ron Jutras - President & CEO

  • Yes.

  • Pierre Yves Terrisse - Analyst

  • So you're going to also recognize, I would expect, losses at the beginning related to this?

  • Ron Jutras - President & CEO

  • I think that is reasonable.

  • Pierre Yves Terrisse - Analyst

  • Have you evaluated at this point in time what could the sort of losses associated with this activity?

  • Ron Jutras - President & CEO

  • We haven't put that number out.

  • Pierre Yves Terrisse - Analyst

  • I guess that was my two questions.

  • Operator

  • Cameron Jeffreys, Credit Suisse First Boston.

  • Cameron Jeffreys - Analyst

  • One housekeeping issue, Ron, if I could. The third-party percentage?

  • Ron Jutras - President & CEO

  • Gerry, do you want to take that question?

  • Gerry Beard - VP & CFO

  • Sure. Third-party content in the quarter was 51 percent.

  • Cameron Jeffreys - Analyst

  • Great. Thanks. The next would be I guess the overhead costs associated with the McAllen, Texas facility. Do you have any ballpark or any kind of quantification you can provide us with in terms of what kind of overhead costs you might expect to save once you kind of move that stuff north of the border?

  • Ron Jutras - President & CEO

  • Our evaluation says that we should get a payback in less than a year based on the cash cost of closing the factory. So I think that gives you some context.

  • Cameron Jeffreys - Analyst

  • Okay, Perfect. That's my two. Thanks.

  • Operator

  • Cherilyn Radbourne, RBC Capital Markets.

  • Cherilyn Radbourne - Analyst

  • The first question relates to your option to repurchase Klaus Woerner's shares. I was wondering if you could give us some idea of when you would expect to announce a decision and what factors you would be considering in making your decision.

  • Ron Jutras - President & CEO

  • I think that we have not really focused in on this issue right now, as you can understand the currancy of the event. It is just not the appropriate time to do it. The option gives us an adequate period of time to assess that situation and make a decision, and I think you just need to give us more time. I can't give you a definitive timeline on that. I think it's inappropriate right now.

  • Cherilyn Radbourne - Analyst

  • Moving onto the currency impact on your earnings, I wonder if you could tell us how much of the 4 cent negative impact was related to accounting translation and how much was transaction exposure.

  • Gerry Beard - VP & CFO

  • The transaction exposure in the Canadian operations represents about 1.5 times the exposure through translation on the revenue line.

  • Cherilyn Radbourne - Analyst

  • Could you repeat that?

  • Gerry Beard - VP & CFO

  • We have two exposures. We have a translation exposure which you have alluded to and a transaction exposure. Transaction exposure arises out of the Canadian operations, both systems and PCG exporting and receiving revenues in US dollars. That number from the Canadian operations is about 1.5 times the translation exposure.

  • Cherilyn Radbourne - Analyst

  • I got it. Thanks very much. That's my two.

  • Operator

  • John Novak, CIBC World Markets.

  • John Novak - Analyst

  • Ron, can you tell us what the capitalized costs for SSP were in the quarter and what they are now total to date?

  • Ron Jutras - President & CEO

  • I believe the number is in the press release. I'll get Gerry to check the number and we'll get back to you if it's different, but I believe we've got about $91 million invested in the overall initiative. That includes both everything we spent on a program, plus our costs we incurred originally when we acquire the technology. So both the project costs and the preliminary cost before we launched the project included in the total.

  • John Novak - Analyst

  • Okay. Can you quantify the amount of the loss that was booked for the ASG Europe health-care order?

  • Ron Jutras - President & CEO

  • Less than 500,000.

  • John Novak - Analyst

  • And I guess earlier in the year you talked about Q2 being a seasonally weak quarter for the Solar operations, and now you're also -- I mean, should we expect Q4 Solar revenues to be of the similar magnitude we sought in Q2, given they're both seasonally weak quarters?

  • Ron Jutras - President & CEO

  • No, I think what we were trying to say to you is that we don't expect to see our revenues necessarily grow in the fourth quarter. That's really because during the winter months you tend to see a bit of a softening. But nowhere near -- we don't shut down for a month in the fourth quarter, which is really (multiple speakers)

  • John Novak - Analyst

  • With the strength of the solar market would you expect it to just be stable in Q4 versus --?

  • Ron Jutras - President & CEO

  • We're looking for more stable performance. It's a record quarter.

  • John Novak - Analyst

  • Should there be any negative impact on operating margins or no?

  • Ron Jutras - President & CEO

  • I think we're expecting to see continued good margin of performance. As I indicated in my presentation, I expect to see very solid performance in the Solar Group in the fourth quarter.

  • Operator

  • Marko Pencak, GMP Securities.

  • Marko Pencak - Analyst

  • First of all, I'd just like to extend my condolences to all the ATS employees with respect to Klaus's passing. I know he was certainly a big dynamo within the firm.

  • Ron Jutras - President & CEO

  • We appreciate that a great deal.

  • Marko Pencak - Analyst

  • I just wanted to -- moving to business -- to understand ASG margins. You talked about the European contract. Ron, if I take your revenues this quarter, if I apply the margins that you reported in the second fiscal quarter of this year, and I sort of back out the $1.2 million FX impact Q2 to Q3, I basically get to the same number. Even if I throw in now the $500,000 on this European contract, I guess I'm not really seeing the benefit of the volume leverage and the balance and all the other things that you have commented on. And I'm really just trying to understand is it just a sum total of a bunch of things that you have identify that is suppressing the margins? Because with all that said, I certainly thought that they would be higher.

  • Ron Jutras - President & CEO

  • I think that overall there is a number of (indiscernible) factors. Like strategically one of the things that was really important in the quarter is we did see this broadening out of performance across divisions like getting the -- making the continued progress where we turned the West Coast operations to a more positive performance and making a positive contribution has been a strategic goal for us, and getting there is very important for us. We saw improved performance in our Asian operations. And we saw a little bit weaker performance in Europe. But overall we're seeing as a broadening trend, which is really something we've been working very hard towards, and we expect that continue.

  • I think in the quarter, the negative offset to that was really what we spent in development costs, which we commented on. To put it in context, we're probably talking somewhere in the neighborhood of 2 to $3 million in development costs incurred in the quarter to support some of these initiatives we're making into health-care.

  • Marko Pencak - Analyst

  • So those all would have been expensed?

  • Ron Jutras - President & CEO

  • Yes. And we're doing this development on projects for customers, which is great because it helps us fund the development. But the requirement is that we would expense that.

  • Marko Pencak - Analyst

  • Just in the same vein, you have mentioned a number of new product initiatives and when you're going to be launching them. Should our expectation then be that these types and magnitudes of costs will continue over the next couple of quarters?

  • Ron Jutras - President & CEO

  • Mike, maybe you want to comment on that.

  • Mike Cybulski - VP of Operations, Canada & Eastern US

  • I think we will continue to some extent at a reduced rate. Of course, we are working very hard to prepare ourselves for this show in September, for example, and also the shows in April. But I expect that to be another 2 or $3 million over that time period. But all of the standard platforms are fully functional machines that with very slight modifications can be sold to customers. So it's not as if I'm building some show cell that have no market value other than demonstration at a trade show.

  • Marko Pencak - Analyst

  • I guess bottom line, and I don't mean to beat this to death here, but you have talked consistently over the last couple of quarters about improving margins and how you're going to (indiscernible) the volume leverage. And certainly from a revenue standpoint you're demonstrating that there seem to be things that keep emerging that don't follow through the same sort of sequential margin as a percentage of revenue improvement. So I guess just from an expectation standpoint, should we just assume between now and September that there's going to be another 2 to $3 million of cost and some volume leverage on top of that?

  • Ron Jutras - President & CEO

  • What we're saying is we're very committed to our technology development program. We're going to continue to invest dollars in that area. It's going to be a drag on margins. I think it's a good investment to the future. But overall I think we're making very solid performance improvements. That's reflected in our margins. Clearly we're not back to our historical levels yet, but directionally that's where we're going.

  • Marko Pencak - Analyst

  • My second question, I just want to understand the accounting associated with when you will start running your SSP through your income statement versus balance sheet. You said no later than September 30th. Can you just share with us what the criteria are, because frankly I don't know when I should be modeling sort of what expenses even if I make assumptions in terms of headcount etc., etc.? What can you sort of share with us that can sort of help frame the modeling of that?

  • Ron Jutras - President & CEO

  • I think it's a very difficult thing for us to answer. The accounting pronouncements basically are based upon our yield -- what we get from ideal standpoint as our processes come up. I think that it's likely to be that -- it's likely to be in that second quarter when we'll come out of the deferred development period.

  • As for a run rate, I think that that's still something that we haven't put out there. And I think it would be premature for us to put it out still. I'm sorry.

  • Marko Pencak - Analyst

  • But yield is the key determining measure?

  • Ron Jutras - President & CEO

  • Yes.

  • Marko Pencak - Analyst

  • Can you share with us what that number is?

  • Ron Jutras - President & CEO

  • I don't have it off the top of my head. It's a more complicated than just a one point in time measure.

  • Operator

  • David Tyerman, Scotia Capital.

  • David Tyerman - Analyst

  • Coming back to ASG, I'm going to echo to some degree what Marko just said. When you talk to investors they are getting pretty frustrated about how long it's taking to get margins back. I'm wondering if you can give us some sense of when you guys are targeting to get back to historic levels.

  • Ron Jutras - President & CEO

  • I think that we want to get into double digits over the course of 2006 year.

  • David Tyerman - Analyst

  • That's helpful. And is it mainly then that you expect to see a continued broadening of the margin improvement from the broadening of the backlog, combined with a general slowing of the development costs that will get you there? Or are there other things too?

  • Ron Jutras - President & CEO

  • I think one of the things is we're seeing a nice acceleration within many of our operations that we carry that as we talked about is in Europe. So to some degree it's a call on what's going to happen in Europe. We're making moves in Europe to broaden our coverage out in order to fuel our growth in Europe, regardless of what happens in the automotive sector over there.

  • But this takes time. And so my perspective is I expect to see continued acceleration, particularly within our North American operations; expect to see good traction being gained in our Asian operations. And quite frankly, I think Europe is likely to be a bit of a drag for probably the next three quarters in any respect.

  • David Tyerman - Analyst

  • On Europe, is there anything that you can pin your hopes on there (indiscernible) your hopes on, but is there anything tangible there where you can really see that that's going to get better? Or is it really that you've got to hope that the new initiative, like things like health-care, are going to pay off, and that there's some uncertainty obviously involved in that?

  • Ron Jutras - President & CEO

  • It is getting better, and I think on a year-over-year basis we saw substantial improvement in Europe. I can tell you we're certainly capturing market share in Europe, and we're doing a bang up job of making sure that our factories are reasonably busy because our competition is not being as successful. I think we are capturing market share, and I think that's an important feature for the future. This move into health-care is strategically very important, because what it means is we broaden out our revenue base; we move into a market which we think is attractive on a long-term basis.

  • David Tyerman - Analyst

  • Just on the PCG, you made a 1 percent improvement sequentially, which is definitely helpful. Can you give us any sense of is that the pace we're going to see on a continuous basis or are we going to get a big impact once McAllen shuts at the end of June?

  • Ron Jutras - President & CEO

  • I think I've given you some indication about McAllen, but maybe I can let Bruce answer the question because he's working very hard on the issues you just talked about.

  • Bruce Seely - VP of Precision Components

  • There are a few factors that are affecting (indiscernible) turnaround. And the China sourcing, there is some product flowing through China into our customers now. The approvals have taken longer than we expected. Some of that has to do with the downturn in volume in automotive. And the Six Sigma activities are gaining traction. We're seeing results from it. And I think it is really a case over the next couple of quarters in watching it gain some traction.

  • David Tyerman - Analyst

  • Is it at the same pace that we saw in the last or is it going to be an accelerating kind of process?

  • Ron Jutras - President & CEO

  • We certainly expect to see acceleration, because I think as Bruce has said we're a little bit disappointed that it's taking a little bit longer to get off the mark.

  • David Tyerman - Analyst

  • I wish you, Ron, and the whole team good luck with moving forward.

  • Operator

  • Peter Sklar, BMO Nesbitt Burns.

  • Peter Sklar - Analyst

  • Good morning. Ron, your disclosure is that the total amount invested in Spheral Solar is 91 million. I'm wondering if you could give us some help us to what the deferred development amount is, the deferred development costs. You ended fiscal 2004 with 15 million of deferred development costs related to SSP. And then you had some reclassification this quarter where you had another 7 million. And then of course you would have whatever you added to it through operating losses. I'm just wondering if you can give us some help there.

  • Ron Jutras - President & CEO

  • The deferred development chunk is with including the transfer that came in with the development costs associated with the pilot line is roughly about $30 million. So the rest would be the factory, the facilities, services, the production equipment, and then the engineering and development costs. I'm sorry, the development costs is in the other number, obviously.

  • Peter Sklar - Analyst

  • Right. How is your staffing? Does the staffing level move up from here or are you at full staffing?

  • Ron Jutras - President & CEO

  • We're not at full staffing. But what I can tell you what we've done is we very purposely went out and we have hired all the technical and engineering staff right up front because that's an important aspect -- that's the talent we need to bring the factory up its ramp curve. But we haven't added operators in for 7/24 production yet, for example. But we have all our technical and engineering talent is pretty well on board. I think there are some additional maintenance people that we're bringing on board as well.

  • Peter Sklar - Analyst

  • My second question is could you talk a little bit about what your thinking is with respect to your accounting policy? Over what period do you anticipate amortizing deferred development costs and depreciating equipment?

  • Ron Jutras - President & CEO

  • I will Gerry talk to that issue.

  • Gerry Beard - VP & CFO

  • It is going to be amortized over a megawatts basis, so on a basically units of production basis for the 100,000 megawatts.

  • Peter Sklar - Analyst

  • Could you explain that?

  • Gerry Beard - VP & CFO

  • As we produce megawatts of production out of the factory --

  • Ron Jutras - President & CEO

  • 1000 megawatts.

  • Gerry Beard - VP & CFO

  • Sorry, 100 megawatts. As we produce megawatts out of the factory, depending on the volume of production, we will be amortizing the deferred development costs.

  • Peter Sklar - Analyst

  • So what's the denominator? Is that the 100 megawatts?

  • Gerry Beard - VP & CFO

  • Yes.

  • Ron Jutras - President & CEO

  • Yes. So it's likely to be -- depending on the growth profile for SSP, that would make it (indiscernible) 20 megawatts, so if we did nothing else that would be 5 years. But obviously we didn't get into this to build 20 megawatts. So it would shorten that down obviously we would scale up our production.

  • Peter Sklar - Analyst

  • So you're saying as it is currently configured you have a 20 megawatts annual capacity, which suggests about 5 years?

  • Ron Jutras - President & CEO

  • Yes,

  • Peter Sklar - Analyst

  • So you're saying -- so if you ramp up production beyond that, the amortization period would be less. Is that what you're saying?

  • Ron Jutras - President & CEO

  • (multiple speakers) scaled up with the increased volume.

  • Peter Sklar - Analyst

  • And on the equipment?

  • Ron Jutras - President & CEO

  • We will follow our traditional accounting policies. I'm not going to get into a breakdown of the individual items and the depreciation policies, but we're following our depreciation policies; pretty much what is disclosed in our financial statement.

  • Peter Sklar - Analyst

  • Just a tax question. When you amortize these deferred development costs, from an accounting perspective is there -- do you tax affect it or does all of it drop to the bottom line?

  • Gerry Beard - VP & CFO

  • It would be tax affected.

  • Operator

  • (OPERATOR INSTRUCTIONS) Marko Pencak, GMP Securities.

  • Marko Pencak - Analyst

  • I just wanted to follow up on the new automation systems for the health-care segment. Should we expect that as you bring these new products on that there will be some selling concessions that you guys offer to try to get those into the market, sort of akin in some ways to the European contract? Or do you think that those will sort of come on at sort of normalized pricing?

  • Ron Jutras - President & CEO

  • My view is that's not our strategy to just cap (ph) to get into the marketplace. We don't need to. And I think that what's happening -- clearly even the issue with the project we transferred into Europe, that was a very calculated decision we made that said look at this; this is a repeat system. The customer is located in Europe; it would make sense that we manufacture this in Europe, and it would be strategically a good thing for us to do. It's not like we discounted the price. We're just recognizing the fact that there are going to be transfer costs associated with developing that skill set.

  • We're not discounting our price to gain our penetration in the health-care market. The health-care market to us is an area which is under-served. It's an area where we see vast potential for our capabilities. We see great opportunities for our standard product platforms, see great opportunities for our skill sets, see great opportunities for our compliance solutions business. And we're going to go after that market in a very deliberate and calculated way.

  • Marko Pencak - Analyst

  • Secondly, just on Photowatt, I know have been increasing your capacity there. Maybe you can give us an update on that. But related to that is I understand that the seasonality from an installation standpoint in the industry. I guess given the shortage in the industry and how most manufacturers are talking about basically being sold out. Why is it that you couldn't basically shift the inventory down into the supply chain, and therefore not incur a seasonal factor?

  • Ron Jutras - President & CEO

  • I don't know if I follow the question particularly, but if you're saying pumping it out to the distributor channel?

  • Marko Pencak - Analyst

  • Yes, because if everybody's sold out, presumably they would be clamoring for it, and why wouldn't they sort of try to secure your production and essentially inventory it until the weather changes for installation?

  • Ron Jutras - President & CEO

  • Marko, that may happen. I think that we're just putting the cautionary tone out there that we have seen the trend in past. You're right. Right now the market is, I would say -- it's showing all the telltale signs of an industry which is really emerging. We're seeing the issues of shortages which are popping up. So we're seeing all those things coming into play, and it makes it a little bit difficult to predict. But I think that overall we're pretty comfortable with where it's going. The issue of silicon shortages is one of the industry is going to have to work its way through. I don't know how long it's going to take them to resolve it. But it's clearly something that we want to make people aware of that it's out there. It's likely to be constraint to the industry growth; probably keep prices relatively buoyant. But it's going to be a concern.

  • Operator

  • Cameron Jeffreys, Credit Suisse First Boston.

  • Cameron Jeffreys - Analyst

  • Can you give us any kind of timetable as to when you might expect to break even in Precision Components?

  • Ron Jutras - President & CEO

  • No, we're not going to do that today.

  • Operator

  • Cherilyn Radbourne, RBC Capital Markets.

  • Cherilyn Radbourne - Analyst

  • Just a final question on your hedge book. You've given us the quantum of the contracts you had outstanding at December 31st. Can you tell us how far that takes you out from a revenue perspective?

  • Gerry Beard - VP & CFO

  • It takes us out a little over a year from a revenue standpoint on a decreasing basis. We don't hedge 100 percent of what we forecast because there is some uncertainty in the forecast. But the near-term is heavily hedged and the latter term is less hedged.

  • Cherilyn Radbourne - Analyst

  • Thank you. And I would just like to echo everybody else's comments and just express my sympathy for your loss this week.

  • Ron Jutras - President & CEO

  • We appreciate that a great deal.

  • Operator

  • David Tyerman, Scotia Capital.

  • David Tyerman - Analyst

  • On the North American quoting activity, perhaps I'm reading your press releases too closely, but I think in Q3 you quoted as being reasonably strong and Q2 very strong. Are you seeing a slowdown in quoting or am I reading too much into the press releases?

  • Mike Cybulski - VP of Operations, Canada & Eastern US

  • Not at all. We are at an all-time high with our quoting activity in virtually every location around the world.

  • David Tyerman - Analyst

  • That's great. Thank you.

  • Operator

  • Mr. Tapp, there are no further questions at this time. Please continue.

  • Ron Jutras - President & CEO

  • I just want to thank everybody for attending today and recognizing the situation that we find ourselves in. And I appreciate your support. Obviously our next conference call, the regularly scheduled conference call is scheduled for May when we announce our year-end results, and we look forward to speaking with you at that time. Thank you very much.

  • Operator

  • Ladies and gentlemen, that concludes the conference call for today. Thank you for participating. You may now disconnect your lines.